What is the Definition of Earnings Per Share?

Earnings per share are the net earnings of the company earned on one share. It is an important and widely used metric which audited financial reports of the companies also particularly mentions in most countries. In other words, it expresses the earning capacity of the company, if divided by value of one share. We commonly call it return on equity. Higher the EPS, the better is the performance and prospects of the company. The track record of EPS for several years reflects the growth rate of the company and potential investors look forward to investing in the company if they see an increasing trend.

Formula for Calculating Earnings Per Share

The equation or formula used for earnings per share ratio is as follows.

The steps to calculate profits/earnings after taxes less after deducting preference share dividend (also known as the profit available for equity shareholders whether distributed as a dividend or not) is as follows:

Net Profit: Take the net profit/loss for the year from the profit and loss account of the company. Audited financials are preferred because it ensures proper compliances of all accounting standards and generally accepted accounting principles. Net profit here means profit arrived after deducting taxes. The tax rate would be different for different countries as per respective laws.

Deduct Preference Share Dividend: In regard to preference shares, the dividend for cumulative preference shares will be deducted even if it is not provided, but for non-cumulative preference shares, the dividend shall be deducted only when it is provided.

A number of Equity Shares Outstanding

The no. of existing equity shareholders is taken. If the number of equity shares changes in the financial period, a weighted average of equity shares is calculated. Weights are given according to the no. of days or months outstanding during the year. Let us understand this with the help of an example.

Diluted Earnings Per Share

Diluted EPS is the EPS after assuming that all convertible securities have already converted into equity. Convertible securities such as employee stock option, convertible preference share, convertible debentures etc. It is the EPS after giving the effect of such securities on both numerator and denominator of the EPS. The numerator increases by the amount of dividend or interest which is not paid in the event of conversion of such securities. The denominator increases by the no. of equity shares issued as a result of such conversion.
So, the formula becomes

Adjusted Earnings Per Share

Adjusted Earnings per Share is the ratio of net profit from regular activities available to equity shareholders. It does not take effect on the following:

Extra Ordinary Items: Items which occur suddenly without any prior notice such as windmill gain, or loss from natural calamities etc

Non-Regular Activities: Activities which are not part of the day to day operations of the company such as the sale of assets, loss due to fire etc.

Adjusted EPS especially serves the purpose of Intra Company and Intercompany comparisons.

Negative Earnings Per Share

Sometimes companies incur losses i.e. negative earnings, which makes the EPS negative. Negative EPS reflects how much money the company has lost per share. The shareholders do not have to pay the share of loss to the company directly, but they suffer in an indirect way. The net loss decreases the value of the firm which in turn decreases the value of the shares. Negative EPS is not always a reason to panic. Sometimes it is a good sign as well. Like for example, when a company develops new products, or when it incurs the one-time big expense, then the negative EPS for a certain period is a temporary phenomenon.

Interpretation / Analysis of Earnings Per Share

Earnings per share are most frequently present in financial statements and is a very reliable figure for investors. It is useful for existing and new equity shareholders for forecasting the value of the shares in future. A high EPS is a sign of better earnings, strong financial position and therefore a reliable company to invest in. The EPS for several years indicates the growth pattern of the company. It also helps in comparison of figures of different companies in the same industry.

About The Author

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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